Top Three Forex Price Action Themes for Next Week

- This week’s calendar was light, but next week’s picks up considerably with multiple Central Banker speeches accented by a flurry of data points. If you’d prefer video content, we discussed many of these same themes in yesterday’s webinar.

This week was rather slow on the news and data front, with the one notable driver being reports around tax cuts in the U.S. potentially being delayed, which created a quick blip of weakness in U.S. equity markets that appears to have carried over globally. The prospect of tax cuts in the U.S. has become a significant market driver, as the Dow Jones Industrial Average put in a move of more than 30% after the U.S. Presidential Election. While equity strength has become somewhat par for the course in the low rate, QE-heavy backdrop of today’s markets; 30% in a year is still quite aggressive by almost any calculation, and this highlights a potentially dangerous theme should tax cuts not get pushed through, as my colleague Christopher Vecchio discussed earlier this morning. The fact that this 30% incline happened while a) The Fed has hiked four times and b) the Fed has started to reduce the balance sheet makes this theme all the more interesting, as the promise behind those tax cuts appears to have encouraged some rather aggressive risk-taking behavior as rates remain extremely low in the face of a shifting backdrop.

Next week’s calendar picks up considerably. Throughout next week, we get a series of Central Banker speeches and this is accented with multiple data points of interest. Tuesday especially looks to be busy, as German and Italian GDP comes out ahead of UK inflation. A little later we get FOMC Chair Janet Yellen speaking with Mario Draghi, Haruhiko Kuroda and Mark Carney in Europe on an ECB panel, and this takes place around the time that 3rd quarter European GDP is set to be released.

Wednesday is also rather full, with US CPI and Retail Sales in the morning, followed by another appearance from Mark Carney later in the day. Australian employment finishes off the Wednesday outlay, and the week closes up on Friday with a Canadian CPI report that will likely keep USD/CAD on the move. Below, we look at three FX markets and themes of interest as we move into next week.

Is Dollar Strength Going to Follow Through, or Will Bears Comes Back?

Probably one of the more surprising themes of this year has been just how aggressively strong the U.S. Dollar was as we came into the New Year. In the immediate wake of the Presidential election, the Dollar was surging – along with stocks and this was widely being called ‘The Trump Trade’. This bullish move in the Dollar extended a move of strength that had actually started in 2014; and just six weeks after the election we had fresh 14-year highs in the Greenback.

But, as we moved deeper into the year, what started as a garden-variety pullback became a full-force sell-off. The pivot around that theme appeared to take place in March. This is when the Fed started talking about the prospect of balance sheet reduction, which up to that point had almost seemed taboo. But, as the Fed began talking about how they wanted to start whittling down the $4.5 Trillion basket of securities that they’d accumulated, market participants began to decrease expectations for near-term rate hikes. The obvious logic being that markets did not expect what had been a really passive Fed to all-of-the-sudden invoke a dual tightening mandate, whereby the money supply was being tightened through both open market operations and rate hikes.

As those rate expectations shifted-lower, so did price action in the Dollar. DXY moved-into a bearish channel that denominated the currency’s movement for most of the first nine months of the year. Eventually, in September, we ran into a key Fibonacci level, which is the 50% retracement of that move that had started in 2014. And slowly, support began to show as buyers began showing up at higher-lows. The move still wasn’t yet bullish, as sellers were continuing to hit bullish price spikes, but the shift had begun as those highs began to get a bit higher while the lows remained bid.

As we said a few weeks ago, what would resolve that resistance in the Dollar probably wouldn’t be something directly-USD related, as the European Central Bank rate decision carried a high probability of the ECB extending their stimulus program. That effectively nullified the hope for higher rates in Europe in the near-term, and as that weakness was coming into the Euro, the U.S. Dollar spiked higher to finally break above the resistance that had held the highs for the better part of the past three months.

We can chalk this up in the most surprising column as well; as coming into the year many banks continued with their parity targets on EUR/USD. But, as that U.S. Dollar weakness was beginning to show and as European data began to tick-higher, markets started to price-in rate hikes out of the ECB for 2018. This was a fairly divergent theme throughout the year: At no point did Mario Draghi ever say that the ECB was considering stimulus exit. As a matter of fact, he point-blank said that they hadn’t on multiple occasions throughout the year when asked at ECB rate decisions.

Nonetheless, markets continued to price-in that prospect under the presumption that the Euro-area wouldn’t need such a gargantuan stimulus program as economic vitality had already started to show. This created a bullish move in EUR/USD that, eventually, saw prices test the 1.2000 psychological level. But life above 1.2000 wasn’t nearly as friendly to EUR/USD as life below, and after a month of testing that resistance, bears finally took-over to drive prices back down to a key zone of support.

When the ECB announced an extension of stimulus, thereby nullifying the theme that had driven the single currency higher for much of the year, the Euro broke-lower. This accounted for a down-side break through that key zone of support that had held the lows in EUR/USD for more than two full months.

After that down-side break of support, prices trickled-back towards this zone, eventually finding resistance on the under-side of this area around last week’s Non-Farm Payrolls report. This was followed by a bearish response that lasted into Tuesday of this week, when EUR/USD set a fresh three-and-a-half month low at 1.1553. Prices have since started to move-higher, and at this point, the big question is where sellers might re-enter to continue this bearish move. The prior swing-high that came-in around Non-Farm Payrolls could be a ‘trap-like’ level for bears, not too dissimilar from 94.44 in DXY at the moment. Prices in EUR/USD could, theoretically, move as high as 1.1837 while this bearish near-term structure remains. On the chart below, we’re looking at a zone of potential resistance that could be operable for lower-high resistance in EUR/USD.

These are both normally bullish factors for a currency, as rising inflation drives higher rates which, eventually attract capital flows (demand). And while this has happened, at least to some degree throughout this year; that relationship appears to have broken down, at least somewhat, as the Bank of England remains uber-cautious around economic activity related to Brexit. When Mark Carney warned that rate hikes were on the horizon in August, the British Pound caught a significant bid to rally all the way up above 1.3650. But, in the wake of those comments, Mr. Carney started to warn that any rate hikes would be slow and gradual, alluding to the fact that the BoE was not on the verge of some tectonic shift with rate-setting policy. This reversed that prior bullish move, and this kept the British Pound in a vicious range as we approached the BoE’s rate decision in November.

When the BoE finally did hike rates for the first time in ten years, the British Pound collapsed. If we’re looking at the move on shorter-term charts, it looks troubling. But longer-term charts show that we were really just mean-reverting within a longer-term range-like area. The day after that rate hike saw support come-in above the prior swing-low, and so far this week we’ve watched prices crawl-higher with some element of reference to the March/August trend-line in the pair.